A STUDY ON TRANSFORMATION OF THE BANKING SYSTEM IN CAMBODIA. CHHUN Vattana

Transcription

1 A STUDY ON TRANSFORMATION OF THE BANKING SYSTEM IN CAMBODIA By CHHUN Vattana THESIS Submitted to KDI School of Public Policy and Management in partial fulfillment of the requirements for the degree of MASTER OF BUSINESS ADMINISTRATION 2005

2 A STUDY ON TRANSFORMATION OF THE BANKING SYSTEM IN CAMBODIA By CHHUN Vattana THESIS Submitted to KDI School of Public Policy and Management in partial fulfillment of the requirements for the degree of MASTER OF BUSINESS ADMINISTRATION 2005 Professor: Pyung-Joo Kim

3 ABSTRACT In a market-oriented economy, the banking sector plays an essential role in facilitating payments and intermediating between savers and investors and in allocating credits by relative risk and return to efficient economic agents. A sound banking sector thus contributes to the smooth operation of the economy and to economic welfare. Cambodia has been transformed a monobanking system into a two-tier banking system since 1989, as a result of changing in central planning economy to market economy during Considering that the proliferation of banks during this period left Cambodia with an excessively large number of banks relative to its size and development and Cambodia still has one of the lowest rates of banking intermediation in the world, we attempt to find a key challenge and option for further reform toward safety net and sound banking system in Cambodia. The analytical results show that the financial health of the banking sector by itself is not enough to promote Cambodia s development, no financial safety nets, such as deposit guarantee schemes and lending-of-last-resort facilities, and lack of some legal frameworks to protect banking system as a whole. To overcome these impediments, the Royal Government of Cambodia has adopted Financial Sector Blueprint for and the central bank has implemented in recent years policies akin to those of bank restructuring, in particular with respect to re-licensing. The paper concludes that further banking reform policy and legal frameworks have been appropriate for Cambodia s circumstances. Transformation of the Banking System in Cambodia i

4 Copyright by CHHUN Vattana 2005 Transformation of the Banking System in Cambodia ii

5 To My Mother, Wife, Daughter, Son And All My Professors Transformation of the Banking System in Cambodia iii

6 ACKNOWLEDGEMENTS I am directly and indirectly grateful to many persons for writing this thesis. I convey my heartiest gratitude and endless thanks particularly to my academic advisor, Professor David J. Behling and my thesis supervisor in KDI School of Public Policy and Management Professor Pyung-Joo Kim for his continuous help and new idea that shaped my thesis as the final outcome. I am ever grateful to KIM, ChoongSoo, the president of KDI School and Korea Development Institute; Professor CHUNG, Chin-Seung, Dean of KDI School, Ph.D., University of Georgia and KDI School authority for giving me the opportunity to study MBA with full scholarship the final outcome of which is this thesis. I really appreciate the direct and indirect helps of KDI School library and friendly staffs of KDI School in all my academic efforts. I am ever indebted to bosom Korean and international friends who helped me during my academic life at KDI School, my colleagues and the National Bank of Cambodia who provide me a lot of data related to my thesis topic. I am indebted to all my family members, especially my mother and wife who provided a lot of direct and indirect helps in my educational efforts both in home and abroad. Transformation of the Banking System in Cambodia iv

7 Table of Contents Page Chapter I. Introduction 1 1. Purpose of the Thesis 1 2. Organization of the Thesis 3 Chapter II. Background and Reform of the Banking Sector 5 1. Brief History of Banking System in Cambodia 5 2. Banking Reform in Cambodia Initiative Reform in the Banking Sector Reform in Banking Sector from 2000-Present Banking Sector Development Current Banking System in Cambodia The National Bank of Cambodia The Commercial Banks The Specialized Banks The Micro Finance Institutions The Other Financial Intermediaries Analysis Selected Ratios of the Banking Sector Prudential Ratios Financial Deepening Solvency Ratio Liquidity Ratio Non-Performing Loan and Capital Adequacy Ratios Risk Management Requirements Cross-Country Comparison of Banking Reform with Loa PDR and Vietnam Approaches to Banking Reform in Low Mekong Country Progress in Banking Reform in Low Mekong Country Cleaning up Balance Sheets and Recapitalization Putting Banks on a Commercial Footing 38 Transformation of the Banking System in Cambodia v

8 5.5. Challenges in Maintaining Reform Momentum 41 Chapter III. Progress in Banking Reform and Remaining Issues Progress in Banking Reform Banking Restructuring Current State of the Banking System Reform of the Foreign Trade Bank Strengthening Banking Supervision Legal Framework The Main Issues of the Banking Sector Dollarization of Economy and Monetary Policy Short Savings and Excess Liquidity Costly Collection of Saving Resources A Lack of Absorptive Capacity High Lending Rates A Systemic Reluctance to Lend Insufficient Information about Borrowers A Lack of Contract Enforcement Other Issues 57 Chapter IV Conclusion and Recommendation Conclusion Recommendation 59 Transformation of the Banking System in Cambodia vi

9 List of Figures Page 1. Total Number of Banks before and after Banking Reform The Banking System in Cambodia (As of Jun 30, 2005) Loans and Deposits as Percentage of GDP and Financial Deepening Solvency Ratio of the Banking System in Cambodia Liquidity Ratio of the Banking System in Cambodia Non-Performing Loan and Capital Adequacy Ratios Ratio of Foreign Currency Deposits to Broad Money Deposit and Lending Rate in Local and Foreign Currency 56 Transformation of the Banking System in Cambodia vii

10 1. 2. List of Tables Operation, Capital, Capital Guarantee, and Reserve Requirement of the Commercial Bank Operation, Capital, Capital Guarantee, and Reserve Requirement of the Specialized Banks Page Operation, Capital, Capital Guarantee, and Reserve Requirement of the MFIs Prudential Regulations (As of Feb 11, 2005) Prudential Ratios of Deposit Money Banks Selected Financial Indicators Cambodia: Interest Rates, Dec Dec / (In percent) Interest Paid by Commercial Bank to Depositors 52 Transformation of the Banking System in Cambodia viii

11 List of Abbreviations NBC : National Bank of Cambodia RDB : Rural Development Bank NGO : Non-Government Organization FTB : Foreign Trade Bank PNBC : People's National Bank of Cambodia ESAF : Enhanced Structural Adjustment Facility IMF : Internal Monetary Fund MFIs : Micro-Financing Institutions LMCs : Low Mekong Countries SOE : State Own Enterprise SOCB : State Own Commercial Bank Transformation of the Banking System in Cambodia ix

12 CHAPTER I INTRODUCTION 1. Purpose of the Thesis Cambodia became independent from France in 1953 and experienced a 17-year period of relative political stability and steady economic growth, starting from a development base similar, if not superior, to that of other countries in South East Asia. During that period, the riel was the legal tender and was used both for financial transactions and as a store of value. Following the March 1970 coup d état that topple the Government, the country was quickly drawn into the international turmoil of the subregion, and eventually into a civil war. The extreme revolutionary experience (an agrarian moneyless society ) of Khmers Rouges during involved bans, inter alias, private property, banking, and money, and brought the country to utter economic and human disaster, during which an estimated one and a half million people, about one-fifth of the population, perished. The Khmer Rouges were driven out of most parts of Cambodia by the Vietnamese in Since the mid 1980s, Cambodia has embarked on economic reforms and reached a no-u turn in 1989, when private property rights were restored and price control was abolished. State-owned enterprises were privatized and increased incentives were provided to local and foreign private investment. After the 1993 general elections, the newly formed Royal Government of Cambodia (the Government) began formulating a comprehensive macroeconomic and structural reform and achieved some significant Transformation of the Banking System in Cambodia 1

13 success in stabilizing the economy. The economy has expanded rapidly during the first half of 1990s. Progress was also made in implementing structural reforms: a two-tier banking system is being put in place and new large denominated banknotes were introduced to promote de-dolarization. The banking sector in particular needs strengthening, given its current low level of development and its dominant position in the present financial system. Cambodia s banking system was thus transformed from a monobanking system into a two-tier banking system by separating the central bank functions from commercial banking activities. To support the reform, legislative framework has been improved. To strengthen the banking system in the earlier 2000 the National Bank of Cambodia (NBC) introduced banking-restructuring program, requiring the existing banks to increase their capital base and to comply with relevant laws and regulations. As a result, in November 2000, nineteen banks were allowed to continue operations, while twelve others were de-licensed and put under liquidation procedure. With these actions, the Government has in mind to bring up all existing banks to a higher standard, improving the soundness and reliability of the banking system, which is crucial for confidence building. However, Cambodia financial sector is at a rudimentary stage, with limited financial intermediation which played only a limited role in facilitating economic development. Due to the weak business and regulatory environment, public confidence in banking system, as well as mutual confidence among banks, remained very low, and financial intermediation by the banking sector continued to be marginal. Transformation of the Banking System in Cambodia 2

14 Cambodia still has one of the lowest rates of banking intermediation in the world: bank loans and deposits account for approximately 8 percent and 12 percent of gross domestic product, respectively. Lending activities of banks continue to stagnate. The proliferation of banks before bank restructuring left Cambodia with an excessively large number of banks relative to its size and development. After banking reform during 2000, still many things remain to be done toward sound and safe banking system in Cambodia including dollarization of economy and monetary policy; short of savings and excess liquidity; a high cost of resources; an insufficient absorptive capacity; high lending rates; lack of borrowers information; a lack of common accounting standards; a lack of legal environment; and the public confidence in the judicial system is very low. The purpose of my thesis is to study on transformation of the banking system in Cambodia in order to find key challenges and options for further reform toward sound and safe banking system. In particular, I would like to study the following issues including the past and current situation of the banking system in Cambodia, the banking reform in Cambodia, the possibility for further reform toward bank soundness in Cambodia, and finding the way forward for Cambodian banking system. In conclusion, my ultimate goal is to find the direction for Cambodian banking sector, by examining the current issues of banking sector, analyzing some key indicators and making cross-country comparison of banking reform in Low Mekong Countries (LMCs) in order to find safety net for further reforms. 2. Organization of the Study Organization of the thesis is as follows: Chapter I will cover the purpose and overview of this thesis. Transformation of the Banking System in Cambodia 3

15 Chapter II will examine the past and current banking system and the banking reform in Cambodia. This chapter will focus on explaining the transformation of the banking sector and finding the key challenges and options for further reform and development. Chapter III will analyze the selected ratios of banking sectors and compare the banking reform in the Cambodia with Loa P.D.R and Vietnam in order to find the remaining issues for further reform toward sound and safe banking system in Cambodia. Chapter IV is the conclusion. In this chapter, I will review the thesis briefly and give my opinion on the main problem of banking system in Cambodia. Transformation of the Banking System in Cambodia 4

16 CHAPTER II BACKGROUND AND REFORM OF THE BANKING SYSTEM 1. Brief History of Banking System in Cambodia After gaining independence in 1953, Cambodia s economy performed relatively well for about a decade until interventionist policies gained influence and banking, along with foreign trade, were nationalized in Increasing strife in the region also led to internal political turmoil, and hopes for economic revival were quashed as the civil war escalated in the early 1970s and Khmer Rouge eventually took over the country. The Khmer Rouge ( ), with a view to creating an agrarian moneyless society, launched a radical economic experiment, whereby private property was denied and money, banks and markets were abolished. After 1979 Cambodia literally had to reconstruct its financial sector from scratch. Under the extreme revolutionary experience of the Khmer Rouge during money had been abolished and the central bank physically destroyed. In 1980, once the Khmer Rouge had been driven out of most parts of the country by the Vietnamese, the riel was reintroduced and state-owned mono-bank (the People's National Bank of Cambodia [PNBC]) was established. Credit allocation became dependent on central planning and had a purely accounting character. The monobanking system had functions such as the monetary authority, the cashier of the Government in the form of the National Treasury, and the provider of banking services including credit, deposits and payment system. During the 1980, therefore, there was only limited monetization of the economy and most non-plan transactions were based on barter or gold, with the later Transformation of the Banking System in Cambodia 5

17 being the universal means of hoarding. During , the Vietnamese disengagement left an unsettled political situation. Massive central bank financing of recurrent budget deficit during that period resulted in high inflation, in the range of % a year (end period), and in an erosion of public confidence in the national currency. The breakup of monobank system started in Since 1989, the banking system had been gradually reformed through transforming the 20-provincial and municipal banks into specialized provincial and municipal banks and had been operating with economic and financial autonomy in their territory, the People's Bank of Cambodia had played its role as monetary authority to direct and supervise these banks. In 1991, the first Commercial Bank (Cambodia Commercial Bank "CCB") was established under the form of state Joint Venture Bank for attracting investors and serving banking activity during the United Nations Transitional Authorities being present in Cambodia (UNTAC). In January 30, 1992, in the 22 nd ordinary session, the 1 st legislature, the National Assembly of the State of Cambodia adopted the Law on the Change of Organization s name and duty of the Bank of Cambodia from the People's Bank of Cambodia to the National Bank of Cambodia, which was promulgated by the council of state in February 8, The Paris peace accord on 23 October 1991 was a political detour of the transforming the economic regime from planning economy to free market economy that made the Cambodia s banking system transformed from the mono-banking system to the 2-tier banking system. Furthermore the state had completely authorized the banking activities to be operated in Cambodia through establishing the commercial banks under the local laws or under the form of foreign bank s branches. Transformation of the Banking System in Cambodia 6

18 These required the National Bank of Cambodia to strengthen its role in improving its management capacity to direct and supervise through having continuously made some Laws and Prakas (Regulations) including the Law on the Organization and Conduction of the National Bank of Cambodia adopted by National assembly on January 26, 1996; the Law on Foreign Exchange adopted by National Assembly on August 22, 1997; and the Law on Banking and Financial Institution adopted by National Assembly on November18, Currently, the Cambodia's banking system consists of the National Bank of Cambodia, with 20 NBC provincial branches, 15 commercial banks, 3 specialized banks, 1 state-owned bank, 14 micro finance institutions, 2158 exchange bureaus and a decentralized system of 31registered NGOs engaging in rural financing. 2. Banking Reform in Cambodia 2.1. Initial Reform in the Banking Sector The transition from a centrally planned to a market economy meant first of all a change in the allocation mechanism of financial resources through decentralization. Since, in the centrally planned economy, banks had no active role in allocation of financial resources this role was initially taken up by non-bank institutions because neither commercial nor central banking skills had yet been developed. The initial reforms gave state-owned enterprises greater autonomy in directing and managing their own business, including financial autonomy, supported by the legal restoration of private property. For the first time since 1975 foreign investors were encouraged. Within the financial sector, reforms in 1990 also gave greater autonomy to provincial and municipal branches o the mono-bank, allowing them to extend credit to Transformation of the Banking System in Cambodia 7

19 all economic sectors. While some of them had sufficient deposits, most had borrowed substantial amounts from headquarters. Inefficiencies of administrative lending under the previous policy contributed to the build-up of non-performance loans in the state banks. In 1991 the People s National Bank of Cambodia (PNBC), which is the central bank of Cambodia and the National Treasury were separated. Two commercial joint ventures between PNBC and private banks were established. In 1992, as foreign investors began to arrive, eight additional commercial banks followed. These were either locally incorporated or subsidiaries or branches of foreign banks. In the same year PNBC reacquired its pre-khmer Rouge name of National Bank of Cambodia. Under the 1992 central bank law, the authorized capital of NBC was set at five billion riels (approximately USD 3.7 million). This law gave it financial autonomy and divested it of commercial banking functions. However, it still lacked independence in formulating and conducting monetary policy, especially in relation to financing of the budget. The result of this deficiency was soon visible. With the collapse of Eastern Europe and the end of financial support from the former Soviet Union, pressure to undertake inflationary, in the range of % a year (end period) financing was aggravate. Although the various measures taken throughout had helped create a new environment in the banking sector, the legal and structural framework of this sector in place by early 1993 was not yet well adapted to the requirements of the market economy. Lack of appropriate skills in the sector and uncertainty at the political level about the issues that needed to be addressed had continued to this deficiency, as did exogenous factors such as the dilapidated infrastructure and macroeconomic instability. Transformation of the Banking System in Cambodia 8

20 Formation of the coalition government following the UN-sponsored general election in May 1993 marked the beginning of new era in the reform process. Assistance from leading countries in the Paris Club to help Cambodia clear its arrears with the IMF enabled the resumption of the relations with the latter. As a result, a more comprehensive economic program was developed under the Fund s Systematic Transformation Facility. The focus of financial and technical assistance under this facility was on development of macroeconomic policy and the establishment of a market-based administrative and structural framework, including restructuring the banking system in mid-1994 the IMF, together with NBC, produced a Policy Framework Paper containing comprehensive economic reform programs to be supported by the Fund s Enhanced Structural Adjustment Facility (ESAF). Within the framework of the overall objectives of the economic reform, the objective envisaged for the banking sector was developing a modern banking system and promoting competition among commercial banks; and strengthening the legal and regulatory framework in order to ensure an effective and smooth conduct of central and commercial banking activities. From 1994 to 2000, the number of banks increased rapidly (see figure 1). At the start of the process, the number of banks reached 33 in 1999 and 32 in 2000 due to the relaxation of requirements for obtaining a license, which was limited essentially to meeting a low minimum capital requirement condition. The size of the banking system in Cambodia, in terms of deposit base, grew from 8.86 percent of GDP in 1999 to percent in This reflects that the public confidence in the banking system and mutual confidence among banks remain very low, and financial intermediation by the banking sector continued to be marginal. Moreover, the Transformation of the Banking System in Cambodia 9

21 proliferation of banks during this period left Cambodia with an excessively large number of banks relative to its size and development. 2.2.Reform in Banking Sector from 2000 to Present Following the adoption of the Banking and Financial Institutions Law in 1999, the banking system has undergone extensive restructuring. In 2000, the government embarked on a comprehensive bank restructuring program with the assistance of the Internal Monetary Fund (IMF). The series of banking reform in Cambodia consists of (i) re-licensing of commercial banks under the newly promulgated Banking and Financial Institutions Law; (ii) strengthening bank supervision; and (iii) reforming and eventually privatizing the state-owned bank Banking Reform under the new Banking and Financial Institutions Law The Banking and Financial Institutions Law, was promulgated in November 1999, three years after its submission to the National Assembly. The new law provided a fundamental framework for banks operations and the NBC s supervisions, which include: (i) the definition of banks and the scope of banking operations; (ii) the supervisory and regulatory power of the NBC, including the NBC s ability to impose disciplinary sanctions and penalties against noncompliant banks; (iii) requirements for the integrity of bank management; and (iv) bank liquidation procedures. The 1999 Financial Institutions Law led to a further extensive restructuring of the banking system. Taking into account the scope and risk of their operations, NBC set minimum capital requirements for different types of institutions as follows: - for commercial banks and each of their branches: 50 billion riel (approx. $13 million) 1 - for specialized banks: 10 billion riel, and 1 Exchange rate: 1USD = 3900 riel Transformation of the Banking System in Cambodia 10

22 - for micro finance institutions: 250 million riel. Under the new law, all private commercial banks were required to be relicensed by the NBC. At end-1999, the Cambodian banking system consisted of 31 banks, comprising two state-owned banks, seven foreign bank branches, and 22 privately-owned commercial banks, and classified them into three categories: (i) viable and fully capitalized banks without need for restructuring; (ii) potentially viable banks requiring some corrective measures; and (iii) nonviable banks. Banks falling into the second category were asked to submit a memorandum of understanding to the NBC describing the details of their restructuring plan, including the timetable for capital increase to meet the new minimum capital requirement set at US$ 13 million. Banks falling into the third category were liquidated. The re-licensing progress was completed in April, During the progress, the NBC closed 15 banks that were either insolvent or not in compliance with the law. Fourteen banks were awarded full banking licenses, and four banks were granted licenses to operate as specialized banks with restriction on the scope of their banking operations. In addition, two international banks with world-wide operations recently closed their branches in Cambodia as a result of a global strategic review of their operations by their respective headquarters. At the same time, a new local bank granted a banking license and started operations in November, As a consequence, Cambodia s banking system currently of 18 banks, comprising one state-owned bank, three foreign bank branches, fourteen locally incorporated commercial banks and four specialized banks. The liquidation of nonviable banks is well under way, with 10 banks already completed. For the remaining five insolvent banks, four banks are under the Transformation of the Banking System in Cambodia 11

23 liquidation process by the court, and one is being liquidated outside the court (see figure 1). Figure 1: Total number of banks before and after banking reform Number of Banks and Specialized Banks from Number of Banks Source: National Bank of Cambodia Strengthening Bank Supervision Bank supervision is being strengthened on two fronts: (i) improving various prudential regulations; (ii) strengthening bank supervision capacity of the NBC. The Central Bank Law of 1996 and the Banking and Financial Institutions Law of 1999 provided an adequate legal framework for bank supervision. These laws were supplemented by a series of regulations issued in early 2000, setting out in greater detail prudential requirements such as capital adequacy requirements, minimum capital, liquidity requirements, limit on large exposures, loan classification and provisioning. Subsequently, these regulations were expanded to cover additional Transformation of the Banking System in Cambodia 12

24 issues such as restrictions on related party lending and acquisition of fixed assets. In February 2002, the prudential regulations were extended to micro-financing institutions (MFIs), and those institutions with operations exceeding certain amounts were required to obtain a license or register at the NBC, and were against undercapitalized banks have been issued, along with regulation on standardized procedures for off-site surveillance and on-site inspections, supplemented by detailed manuals for these operations. The supervision capacity at the Bank Supervision Department (BSD) of the NBC is gradually improving. The number of staff has been increased from about 40 to 60 in the last two years. In the past, the BSD had relied on international audit firms for conducting on-site inspections of banks to compensate for their limited experience and capacity. With technical assistance from the Asian Development Bank (ADB), the NBC is in the process of developing the capacity for off-site and on-site surveillance activities, and has already started to conduct on-site inspections on a limited scale. With the completion of bank re-licensing process, the NBC is now shifting its emphasis and resources to enhancing supervisory activities Restructuring of the Foreign Trade Bank The FTB was a remnant of the mono-bank system in the It had operated commercial banking functions as a department of the NBC without a banking license and without an independent capital base. To establish a banking system operating on modern principles of good practice, the separation of the FTB from the NBC and the restructuring of the FTB as a fully independent state-owned financial institution operating on commercial basis were seen as essential. The reform of FTB s operation was also critical for its eventual privatization, to complete the transition toward eliminating state involvement in the banking sector. Transformation of the Banking System in Cambodia 13

25 The FTB was legally separated from the NBC in August 2000, and a Board of Directors was established to provide operational independence. It completed an external audit (which was substantially qualified given the poor state of the accounts), and received its banking license in December However, during the transition period, the FTB was still under the NBC ownership who also provided physical assets to satisfy the initial minimum capital requirement of 10 billion riels. In June 2001, the NBC issued a central bank note for a full recapitalization of FTB to 50 billion riels (US$ 13 million). To complete the separation of the regulatory function of the NBC and the commercial bank function of the FTB, the Ministry of Economy and Finance (MEF) issued a recapitalization bond (40 billion riels) to replace the capital provided by the NBC and became the majority shareholder in April In January 2003, the FTB publicly announced its intention to privatize and to seek out strategic investors with international banking experience willing to run the operation of the FTB in a manner consistent with the broader objectives of financial market development in Cambodia. Meanwhile, in an effort to introduce a market-oriented business culture, the first outside director with commercial banking experience was appointed to the FTB Executive Board in June At the same time, the FTB worked closely with its external auditors to eliminate long-standing problems in their accounts by reconciling outstanding discrepancies and provisioning against unrecoverable bad loans. Although the external audit of their end-2001 accounts remained qualified due to technical reasons, it received an unqualified opinion on a special audit of their financial position at end-march, With technical assistance being provided by Australia, progress is also under way to modernize the FTB s operations by improving the management information system, developing procedure manuals for Transformation of the Banking System in Cambodia 14

26 key areas such as credit processes and internal audit, computerizing operations, and establishing various training programs for the staff Legal Framework The current legislative framework has largely been developed in the second half of the 1990s in response to deficiencies evident in earlier measures. These recent reforms have focused largely on re-regulation of a system that had earlier suffered from excessive liberalization following the collapse of the former centrally planned economy. The main elements in the new framework are: (1) the law on the organization and conduct of the National Bank of Cambodia, promulgated in January 1996, replaced the 1992 law; (2) the law on foreign exchange, enacted in May 1997, replaced the law on the management of foreign exchange, precious metal and stones promulgated in 1991; (3) the law on banking and financial institutions enacted in November 1999 and a number of subsequent regulations (Prakas) issued by the NBC. However, the Law on Negotiable Instruments and Payment Transactions was already adopted by the Council of Ministers meeting on April 4, 2003 and submitted to the National Assembly for approval. This law will become an important instrument in strengthening the payment system by reducing the payment system risk, improving liquidity management, and promote stability in the development of a sound financial system. Thus the banking system is still developing. Until now the focus of reform has been on issues relating to the build up of public confidence in the banking sector, chiefly by strengthening the regulatory system and prudential supervision Uniform Chart of Accounts The NBC continued to monitor the implementation by banks of the uniform chart of accounts (COA) prepared in accordance with the accounting rules prescribed Transformation of the Banking System in Cambodia 15

27 in the international accounting standard as well as the Cambodian accounting standard. Commercial banks and specialized banks started to implement the COA on the 1 st of January By the end of 2004, thirteen commercial banks and three specialized banks have fully integrated the uniform chart of accounts into their system, except for one bank that still lagged behind due to a problem related to outdated computer software system which made adjustments and changes to the existing system more difficult than in other banks. Facing this constraint, the NBC gave additional time to this bank to find remedies to its problems and to improve its accounting system in line with the requirements of the uniform chart of accounts. With the aim of promoting transparency and developing the confidence of the public in the banking system, the NBC has recently required all banks to publish their annual financial reports audited by the external auditors, starting in The disclosure of the annual financial reports will enhance transparency in banking operations and improve banks' accountability toward their customers, which in turn could enhance banks' credibility and promote the banks' reputation. To pursue this plan, the NBC held a discussion with external auditors to draw up a disclosure report form to be published by banking institutions Payment System Reforms Progress has also been made in the area of payments system reform. A clearinghouse checks denominated in riels has been in operation since However, there were no such facilities for US dollars, raising concern among banks about the safety of the settlement of their dollar transactions, and posing a serious threat to the development of a sound financial system under the highly dollarized economy 2. In 2 The banking system continues to be highly dollarized, with 94% of the deposits and 96% of the loans denominated in the US dollars. Only a few banks take riel deposits, and the FTB dominates the market with a share of 84%. The high degree of dollarization poses a significant challenge for bank supervision, as the lender-of-last-resort functions of the NBC will be severely impaired. Transformation of the Banking System in Cambodia 16

28 response, the NBC established a second clearinghouse for checks denominated in US dollars in January 2001, which soon exceeded the first clearinghouse in terms of volume. Both clearinghouses operate under strict solvency rules, and the NBC does not assume any risk associated with their operations Banking Sector Development The impact of the banking regulations has been very significant in Cambodia. Altogether, they lead to the closure of 15 banks that could not cope with the new licensing regulations. Generally speaking, the banks today seem financially healthy. With the assistance of Asian Development Bank (ADB), NBC has adopted late 2001 the Blue Print for the financial sector development Since then the strategy pursued by the central bank has been to (i) set up/improve the regulatory framework, (ii) Initiate and impose accounting (international) standards, (iii) Implement banking supervision and prudential ratios. Three basic laws and subsequent prakas, especially since 2001, have been passed. Since that year the cleaning up activity translated into detailed regulations and prudential standards that affect capital adequacy, minimum liquidity, exposure ceilings and loan provisioning. In parallel, the only state-owned bank (FTB) was recapitalized in view of meeting the new requirements and preparing the steps for its privatization. As a consequence, the banking sector is today heavily capitalized, with on average a solvency ratio close to 50%. It is also heavily liquid. 3. Current Banking System in Cambodia As in neighbouring transitional economies, the Cambodian banking system had to shift recently from a mono-system towards a three-tire system. A new legal and financial framework has been set up. This was made through a set of 3 laws including Law on the Organization and Conduct of the National Bank of Cambodia (26 January Transformation of the Banking System in Cambodia 17

29 1996); Law on Foreign Exchange (22 August 1997); Law on Banking and Financial Institutions (18 November 1999) and a number of sub-degree that are updated regularly. After several years of serious reforms, there are three levels of financial institutions: a central bank, 18 commercial banks and 14 microfinance institutions 3 (see figure 2). Particularly during the past five years, serious efforts have been devoted to clean up the financial sector. Since 2000, 15 banks have been closed down. These drastic methods have proved effective. The three-tier banking system includes on the top, a central bank performing mostly supervisory tasks, then commercial banks and lastly micro-finance institutions (MFIs). Let s see what are their respective role and activities The National Bank of Cambodia The transformation of the previous system was legally set up in January 1996, as the National Bank of Cambodia (NBC) took a new role. The central bank was created by Law on the Organization and Conduct of the National Bank of Cambodia promulgated on 26 January Its mission (art 2) is defined as to determine and direct the monetary policy aimed at maintaining price stability in order to facilitate economic development. As the central bank, NBC is to act as the sole issuer of national currency in the Kingdom of Cambodia. The bank licenses, regulates and supervises financial institutions ; it also participates in the formation and supervision of the money and financial markets. The Law provides for the bank to set interest rate (art 7). A Board of Director, comprising 7 members chaired by a governor, manages the bank. 3 Licensed MFIs number 9. But there are also 27 MFIs that are simply registered (basically NGOs). Transformation of the Banking System in Cambodia 18

30 The central bank reports to the National Assembly and the government. Its capital is entirely subscribed by the government. The Bank is the sole depository-in the national currency- for the national Treasury. The foreign currencies received by the Treasury are deposited with the Central Bank that credits its account with the counter-value in Riels. The bank is the adviser to the government on monetary and financial matters, for instance it in public debt management, or through the issuance of public securities. The bank is legally authorized to purchase government securities under several conditions. As a bank the NBC can extend credit to the National Treasury with strict limitations: (i) (ii) (iii) (iv) The interest rate should be equivalent to the refinancing rate (to banks) The maturity cannot exceed three months The loan is supported by negotiable government securities, and lastly, The consolidated outstanding of the credit granted to the government cannot exceed 10% of domestic budget revenues from the previous year (excluding foreign grants and sale of assets). In other words, strong safeguards have been put to prevent any lax fiscal by a government that would have seen the Central Bank as a money provider. The bank is not allowed to make any equity investment in banks, financial institutions or commercial firms. It is neither allowed to acquire real estate property except for carrying out its daily activities. The only investments that are accepted (not exceeding 5% of its capital) are investments made in companies whose activity is relevant to its basic functions; for instance in firms dealing with credit appraisal, printing or clearing, etc Commercial Banks Transformation of the Banking System in Cambodia 19

31 There are presently 18 banks in Cambodia (see figure 2). A remarkable feature in the region is that there is only one remaining state-owned bank, namely the Foreign Trade Bank (FTB). This bank was originally the foreign department of the previous monobank. Created in August 2000, the bank should soon be partially privatized. The 16 other commercial banks are fully private. Licensing: the delivery of a license relies on standard criteria: qualification of shareholders, honesty of managers and minimum equity. The license is available for three years. An application for a license costs only 900 US$, but the bank has also to pay for an annual license fee of about 17,500 US$ for its headquarters (70 M riels) and 14,000 US$ for each branch (56 M riels). For instance a bank with 10 branches should pay annually to the central bank a sum of 157,500 US$. This amount is substantial. Minimum capital: The minimum capital for a commercial bank has been fixed at 50 Billion riels (about 13 million US$). Such an amount is very high even by world standards. That level has been probably fixed to keep away adventures and amateurs, after several experiences in the beginning of the 90 s. Capital guarantee deposit: A capital guarantee deposit, representing 10% of the registered capital has to be kept with the central bank. Originally half of this deposit (5%) was bearing no interest; the other half (5%) was bearing an interest equal to 3/4 15 of the 6-month SIBOR (Singapore Interbank Offered Rate). Since 2005 the conditions became less draconian. An interest is now paid on the totality of the deposit: If deposit is made in riels, the rate equals 4/8 of the 6-month refinancing rate of NBC; if the deposit is made in USD the interest rate paid is3/8 of the 6-month Sibor. Table 1: Operation, Capital, Capital Guarantee & Reserve Requirement of the Commercial Bank Operations Capital Capital Guarantee Reserve Fees Transformation of the Banking System in Cambodia 20

32 Requirement 1. Credit, leasing, 10% bearing - Application 3.5 guarantees and commitments under signature. 50 Billion riels interest: - in dollar at (3/8) or 75% of six month 8% on deposits million riels - License: valid for 3 years 2. The collection of deposits from the public. 3. The provision of means of payment and SIBOR - in Riel at (1/2) of six-month refinancing rate - 70 million riel (Head office) - 56 million riel (Branch) the progressing of payment. Source: National Bank of Cambodia 3.3. Specialized Banks Licensing: The specialized bank pays a license fee that is lower than for the commercial bank. Its annual license fee is reduced to 10 million riels for the headquarters and 8 million riels per branch. For instance, a 10-branch specialized bank would pay 90 M riels, or 22,500 US$ per year. Minimum capital: The minimum capital for a rural credit specialized bank is 10 Billion riels (2.5 Million US$). A capital guarantee deposit of 5% of the registered capital has to be kept with the central bank, bearing no interest. Reserve requirement: Commercial and specialized bank have also to put, as a reserve deposit, 5% of the deposits they have collected from the general public to the central bank. Transformation of the Banking System in Cambodia 21

33 Table 2: Operation, Capital, Capital Guarantee, and Reserve Requirement of the Specialized Banks Operations Capital Capital Guarantee Reserve Fees Requirement An entity carrying out only one of these three 10 Billion 5% no interest: 5% on deposits - Application 0.5 million riel basic activities shall be riels - License: valid known as a specialized for 3 years bank million riel (Head office) - 8 million riel (Branch) Source: National Bank of Cambodia 3.4. Micro-financing institutions (MFIs) According to the latest prakas, a Microfinance institution is defined as an entity delivering financial services such as loans and deposits to the poor and lowincome households, and to micro-enterprises. The scope of activities opened to MFIs is very large (saving deposits, credits) except that they cannot open check accounts. Their legal status is large since they can be either a liability company or a cooperative (credit union). Depending on their size, MFIs are either licensed or registered. For historical reasons, the Law assumes that an MFI has already started its activities as an NGO. If an NGO adds some financial activities have developed beyond a certain threshold, the MFI has then to upgrade to a license status. Registration: The registration of an MFI with the NBC is compulsory for all NGOs, associations and other entities if they meet the following criteria: (a) If the NGO is engaged in credits, when their outstanding is above 100 million riels (25,000$) (b) If the NGO is engaged in saving collection, when they have more than 100 depositors or if they collected more than 1 million riels (250$) Transformation of the Banking System in Cambodia 22

34 Licensing: The licensing becomes compulsory for a registered MFI when it meets the following conditions: (a) If the MFI is engaged in lending activities, when the outstanding credit is above 1 billion riels (250,000$) or if they have more than 1,000 borrowers (b) If the MFI is collecting deposits, when it receives more than 100 million riels (25,00$) in deposits, or if it has more than 1,000 depositors. The annual licensing fee is lower than for a bank since it is only 1 M riels (250$). Capital: The minimum registered capital is 250 million riels (62,500 US$). The MFI should also deposit 5% of this capital into a non-interest bearing account with the Central Bank. Reserve requirement: The MFI should also deposit 5% of its deposits as a reserve requirement into a non-interest bearing account with the Central Bank; However compulsory saving, which are savings required as condition to participate in a credit scheme, shall be excluded. Table 3: Operation, Capital, Capital Guarantee, and Reserve Requirement of MFIs Operations Capital Capital Reserve Fees Shall be excluded KHR 250 million guarantee Requirement - Application from: 5% no interest 5% on deposits 50,000 riel - Leasing rate - License: valid derivatives and for 3 years spot and forward - 1 million riel market. Providing payment services. Source: National Bank of Cambodia Transformation of the Banking System in Cambodia 23

35 3.5. The other financial institutions There are three types of financial intermediaries in Cambodia: (i) the banks (also sometimes called commercial banks ), (ii) the specialized banks (also sometimes called rural commercial banks, and (iii) the micro-financing institutions (or MFIs). The Bank is defined as a legal entity that normally carries out three types of activities: (i) collecting deposits from the public, (ii) granting loans, and (iii) facilitating transaction in providing means of payments. A bank can be incorporated either as (i) a limited company under commercial law or as a (ii) credit union, consequently non-subject to commercial status. In the later case, the cooperative or mutual society has to belong to a federative 4 body, which insures financial soundness of their members (art 11). The specialized bank 5 is a financial entity that engages into only one of the three activities list above. Consequently this financial agent is either a borrower or a lender but it cannot be both. The microfinance institution (or MFI) is a financial entity that provides financial services such as loans and deposits to the poor and low income households and to micro-enterprises. Consequently the criterion applicable to a MFI is no longer the type of activity of the access to the public but the profile of their customers. Although these intermediaries are different in terms of resources, fields of activity, types of loans and prudential constraints, they have to follow general conditions aiming at protecting their depositors (against any mismanagement by bank s managers) and ensuring that the general public keeps confidence into the banking system. 4 Apparently, none of the banks or MFIs in Cambodia have so far consolidated into a federation 5 New concept: Until the 1980 s a bank was said specialized when its activities were limited to a specific economic sector: agriculture, industry, trade, housing, etc Transformation of the Banking System in Cambodia 24

36 Figure 2: THE BANKING SYSTEM IN CAMBODIA (As of Nov 30, 2005) NATIONAL BANK OF CAMBODIA (CENTRAL BANK) 15 Commercial Banks 3 Specialized Banks Micro Finance Institutions 20 NBC Provincial Branches 1State owned - Foreign Trade Bank 3 Foreign Branch Banks - First Commercial Bank - Krung Thai Bank (7) - May Bank Note: License is to be renewed every 3 years. The date of opening PRAKAS Source: National Bank of Cambodia 11 Locally incorporated - Advanced Bank of Asia - Cambodia Asia Bank - Canadia Bank Ltd. (2) - Cambodian Commercial Bank (1) - Cambodia Mekong Bank (3) - Cambodian Public Bank (6) - Singapore Banking Corporation - Union Commercial Bank (4) - Vattanac Bank - ACLEDA Bank Limited (5) - ANZ Royal Bank Cambodia Representative Office - Standard Chartered - Vietnam Bank for agriculture & rural development 1 State owned - Rural Development Bank 2 Privately owned - Peng Heng S.M.E Limited - Cambodia Agriculture Industrial Specialized bank i14 Licensed 1-Enatien MoulethanTchonnebat (EMT) 2-Hatthakaksekar 3-Tong Fang Micro finance Ltd. 4-Thaneakea Phum Cambodia 5-Cambodia Entrepteneur Building Ltd. 6-Seilanithih 7-Angkor Microheranhvatho Kampuchea 8-Vison Fund (Cambodia) Ltd. 9-Credit Co. Ltd. 10-Prasac Micro Finance Institu 11-Farmer Union Dev.Fund 12-Cambodia Business Integrate in rural Development 13-Maxima Mikroheranhvatho 14-Enatean Poalroach Rongroeng NGOs - Registered 31 - Unregistered around 60 - Kampong Cham (Jan 04, 2000) - Sihanouk Ville (Jan 04, 2000) - Siemreap (Jan 04, 2000) - Battambang (Aug 30, 2002) - Svay Rieng (Aug 30, 2002) - Kampot (Aug 30, 2002) - Kandal - Prey Veng - Kampong Thom - Takeo - Pursath - Kampong Chhnaing - Kampong Speu - Koh Kong - Preah Vihear - Kratie - Ratanakiri - Mondolkiri - Stung Treng - Bunteay Meanchey Exchange Bureau Registered Phnom Penh Provincial Transformation of the Banking System in Cambodia 25